The good news is that there is a $25.7B market for RSH credit default swaps. Credit default swaps were originally created so that a company’s creditors could buy insurance in case the company couldn’t pay back its debt. But just like life insurance, anyone can buy a CDS on anybody (as long as there’s a seller).

Now some third parties stand to gain $25.7 billion if RadioShack decides to go under, which is kind of like 31 people holding life insurance policies on your mother, if your mother was RadioShack.

The contract sellers don’t want to pay out $25.7 billion, so they went ahead and loaned RadioShack more money to keep it on life support. At this point I suspect that Radio Shack would just like to be put out of its own misery, but the counterparties are hedge funds with lots of money.

I guess the moral of the story is, if you’re gonna take on debt, take on enough debt that someone out there can’t afford to see you fail.

Like this:

Suppose that you are a happily married and risk-averse individual. Being risk-averse, you prudently take out a life insurance policy on your spouse. Things are going splendidly until one day OH NO your spouse accidentally gets thrown in front of a bus. And dies.

You’re pretty bummed about this, but your grief is somewhat mitigated by that multimillion-dollar life insurance policy. This is called risk-hedging.

Now, suppose that you also own a diverse basket of stocks that look like the S&P 500 index. You know that markets sometimes suffer downturns and you would hate to have your portfolio wiped out. You purchase some S&P 500 options so that, if your stock portfolio gets demolished in a market crash, you can sell the S&P 500 index at a price that is acceptable to your risk profile. This is another form of risk-hedging.

Nobody knows where the market’s gonna go. Maybe you like the perceived safety of long-dated options. If you’re Nassim Nicholas Taleb betting on black swan events, you buy long-dated options on the cheap hoping some won’t expire worthless. Or maybe you prefer to buy something closer to expiration so your cash isn’t tied up.

Think back to the life insurance policy you had on your spouse. Maybe it was a bit silly to pay monthly premiums for all those months your spouse didn’t die. Maybe you should have waited until 20 minutes before pulling the plug to purchase that life insurance policy*.

Trading activity on S&P500 options on Nadex, just before expiration. The rightmost column shows the value of the underlying index. The circled bids are the options that expired in the money.

Critics made some noise about how this amounts to little more than gambling. In a zero-sum game like the options market, every individual who buys an option to lower personal risk has a counterparty taking an equal and opposite risk. The market allows those who don’t want risk to purchase downside protection from those who do. By giving individuals the freedom to tailor the world to their personal risk preferences, the options market improves social welfare and ensures peace and prosperity for all.

*It might be hard to find an insurer for your spouse on life support, but surely there must be someone out there willing to bet on the off-chance that your spouse makes a miraculous recovery once disconnected from the ventilator.

Like this:

If my health insurance provider were a rational player, it would hire somebody to shoot me when I get injured, to avoid paying for my expensive trips to the hospital.

If my life insurance provider were a rational player, it would pay for me to receive the best health care possible, to make sure I live forever and maximize the premiums paid over my lifetime. If I don’t die, State Farm never has to pay out benefits.

Legally, neither provider is allowed to do that. From a capitalist perspective, insurance is a terrible industry. It takes cash out of circulation by receiving premiums, and saves the money in an illiquid vault for a rainy day. Unlike banks, insurance companies can’t even loan this cash hoard out to borrowers.

It used to be the other way around. Long before Obamacare and socialized insurance risk, wealthy individuals with real estate and property could independently sell insurance. They would meet at Lloyd’s Coffee House to sign the deals. Pay me £x per month, and if your ship sinks, I’ll give you my house. The trade of immovable assets for cash payments created a liquid marketplace, ensuring peace and prosperity for all.

At some point, the insurance underwriters got greedy and sold more insurance policies than they could afford to pay out. Government agencies stepped in, regulating the insurance industry into the anticapitalist behemoth you see today. Socialism Vs Capitalism is an enduring conflict.

So let’s say we deregulate and privatize health insurance. What about the high-risk individuals who cannot afford health insurance, like Elaine?

Elaine will be fine. She would set up a death pool for herself, and open up bets to the public market. Many would bet for her demise, driving up prices. The counterparties betting on Elaine’s survival would then be highly incentivized to keep her sorry ass alive. They would probably pay for my health care.

Like this:

Terminally ill patients sell their life insurance policies to intelligent investors. Terminally ill patient gets a small pile of money upfront to make their last days more bearable, and the investor gets a huge payout at the end of the day. Brilliant investment idea. I should sell my life insurance policy too! Over 50% of Americans die within 2 years after retirement. That’ll be my selling point.

Selling your life and selling a house have more in common than you’d think. The seller puts a listing on the market. Prospective buyers do research and get inspections; there are offers and counteroffers until the seller accepts a bid. The seller doesn’t literally peddle his own life, of course, but his life-insurance policy. The distinction is in many ways moot, however, as the sales value is inextricably linked to a cold-eyed estimation of how much longer the seller has to live.

I can’t believe an entire market already exists for this sort of thing.

Large portfolios also allow mortality to be packaged for sale in ways that, for better or worse, recall the byzantine ingenuity of the subprime era. Settlements can be pooled, sliced and recombined into a dizzying array of financial instruments, including ‘’death” bonds, derivatives, notes and swaps.